Falling vacancy rates signal sharply rising rents in near future

After about a decade of very low rent inflation, rising rents are emerging as a consequence of economic recovery. Rental vacancy rates have been dropping sharply, and rental market analysts are warning that double-digit rate increases are on the horizon. Further economic recovery may be at stake as rising rents feed inflation and subtract further from consumer spending already under stress from rising gas and food prices.

Why rental vacancy rates are falling

Rental rates have increased on average less than 1 percent per year over the past decade, according to the Commerce Department. During the recession, people who couldn’t afford to live on their own either doubled or tripled up with roommates or moved back in with their parents. Now many of these people are back on the market looking for their own place to rent. Millions of people who lost their homes in the foreclosure crisis, which continues, are also looking for apartments. Rental vacancy rates dropped from 10.3 percent in the third quarter to 9.4 percent in the fourth quarter of 2010. The 1.3 percent decline was the second-largest on record and the lowest rental vacancy rate since 2003. As rental vacancy rates continue to drop, rents will rise and the overall trend will accelerate.

How high will rents rise?

Rental rates are rising rapidly in every major U.S. metropolitan area and posing a major inflation risk. In the past three months, rents for primary residences are up 2 percent. Overall rents have increased 1 percent. In the next year, rents are expected to rise anywhere from 3 to 10 percent. In high-demand rental markets, such as San Diego, Seattle and Boston, increases could top 10 percent in the next two years. Housing costs account for 40 percent of the Federal Reserve’s core inflation calculation. Rising rents are expected to double the U.S. inflation rate from 0.8 percent in 2010 to 1.6 percent this year. By the end of the year, the U.S. inflation rate could reach 2 percent– the rate of inflation the Fed shoots for without factoring in housing, gas and food prices.

The challenge to meet rental demand

The housing crisis has changed the perception of home ownership in the U.S. as home prices continue to decline. Americans understand the economics of housing better now, and as long as a home isn’t a good investment, more will choose to rent. Rising rents are a function of supply and demand. Nearly 80 million aging baby boomers and 4.5 million people who lost their homes to foreclosure are entering the rental market. Yet multifamily rental construction starts plunged from nearly 350,000 units annually before the 2008 financial collapse to barely 100,000 annually. According to the Center for American Progress, more than 40 million new rental units may be needed in the next 30 years. In the short term, a lack of long-term financing options has few developers willing to risk building more rental housing.